CVVTF - Covestro: Our Comments On Q3 Results

Summary

• The negative pricing delta was confirmed in the Q3 numbers.
• Higher working capital requirements and dividend payments increased debt exposure.
• Covestro lowered its 2022 EBITDA. We decided to move our rating from buy to neutral.

Today, we are analyzing Covestro's ( CVVTF , COVTY ) Q3 results and we will copy and paste some key notes from our previous Q2 publication. Our buy case target recap was based on an asset replacement cost analysis, a tasty dividend yield, and current share repurchases. These were Mare Evidence Lab's margins of safety assumptions. Due to higher working capital requirements, we were forecasting more debt and reducing our expectation of the company's EBITDA. Despite that, on a next twelve-month (NTM) basis, Covestro's valuation was at a discount compared to its peers and there was " no credit on its return to mid-cycle earnings" . In the short-term horizon, the Q3 outcome simply proved a negative scenario that we should price in. Over the long term, we still believe that Wall Street is not fairly pricing Covestro.

Q3 Results

As already happened in Q2 , the negative trend was confirmed. Both in the Performance Material and Solutions and Specialties divisions, the company increased its revenue line by 6.6% and 6.1%, respectively. Core volumes were down by more than 6%, and FX evolution was a negative tailwind that totally offset Covestro price increases.

Source: Covestro Q3 results presentation

Going down to the P&L performance, the negative outcome further deteriorated. Covestro was not able to pass through raw material inflationary pressure and higher energy costs. Hence, the company delivered a negative pricing delta. As mentioned in the press release , there were significant tailwinds in wage increases and freight costs.

Source: Covestro Q3 results presentation

Cross-checking Wall Street consensus, the Performance Materials EBITDA segment was significantly down compared to expectations. Covestro achieved €53 million for its results versus an average estimate of almost €200 million. This was totally due to the high energy price recorded in Europe. Solutions and specialties EBITDA reached €290 million and were above expectation. Versus the prior year's EBITDA, the segment was supported by positive FX evolution and by lower inter-segment transfer prices mainly in Engineering Plastics. Compared to the Q3 2021 results, EBITDA was down by 65% and FOCF by more than 91%. As already mentioned, net debt increased to €2.8 billion and now the implied net debt/EBITDA is at 1.6x on our 2022 numbers.

Conclusion and Valuation

The company lowered and narrowed its 2022 guidance, forecasting an EBITDA in the range between €1.7 billion and €1.8 billion. Here at the Lab, we are reducing our expectations, and if we maintain a 5.5x multiple on EBITDA, we move our target from buy to neutral. Adjusting our equity value for the higher debt, we derive a target price of €32 per share, in line with the current stock price .

Source: Covestro Q3 results presentation

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